The Magic of Income Producing Property
Many new investors are overwhelmed with the amount of information presented in introductory seminars and training sessions. There are many choices at the real estate smorgasbord table. Some instructors say, “Buy, fix, and sell—it’s the easiest way to payday.” Others say, “Buy, rent, and never sell—it’s the only way to long-term wealth.” Who is right, and who is wrong? Well, there is no right or wrong answer…if you know what you are doing.
As an investor, you must choose which strategies to use to build your wealth. You must decide what your short and long-term goals are, and then establish a plan to meet those goals. It is more than likely that such a plan will include both “buy, fix, and sell” and “buy, hold, and rent.”
Each time you look at a property, you must determine your exit strategy before moving to buy the property. If your exit strategy is to buy, fix, and sell the property for quick cash, you need to buy a property that will be easy to sell. You must also analyze that property with a buy, fix, and sell analysis formula to make sure you are buying at a price that will allow a quick sale, which will usually involve offering a substantial discount to the new buyer. Buy, fix, and sell strategies are great for generating quick profits, but unless those profits are invested in an income-producing asset, they generally will not provide you with long-term wealth and financial freedom. “Buy, fix, and sell” is a great strategy, but if you stop buying, fixing and selling, your income also stops.
If your exit strategy on a particular property is to keep the property as a rental, buy a property that will be easy to rent. You must analyze the property using a rental analysis formula, rather than a buy, fix, and sell formula. The rental-analysis formula will ensure that the price you pay for the property will allow you to have a positive cash flow right from the start. This is a key ingredient to being able to keep the property for the long haul. Buying a property and keeping it for several years, only to lose it because you can no longer afford the negative cash flow, does not make sense. Only keep rental properties that provide you a healthy cash flow right from the start!
Many people are afraid of rental properties because of all the landlord horror stories they have heard over the years. Most of those stories are probably true, but they don’t have to be your horror stories. If you “buy right” to start with, a lot of potential problems are already eliminated, and you will have enough cash flow to hire a management company to manage the property. Then you will not be faced with conducting day-to-day interactions with your tenants.
However, even if you hire a management company, you do need to know enough about the rental business that you could manage the properties yourself should it become necessary. Here are a few tips about buying and managing rental properties that can help you get rid of your fear of buy-and-hold properties.
Advantages of Owning Income-Producing Rental Properties
• Generate real-time cash flow you can spend now. You can use this cash flow to live on, and/or invest in additional properties.
• Create long-term wealth. Your tenants pay off your mortgage over time, leaving you with a free-and-clear (no mortgage) property. If you had 10 free-and-clear properties, each bringing in $1,000 per month, could you have financial freedom?
• You get the additional benefit of long-term property-value appreciation. This factor alone can create millionaires. Yes, property values do go up and down with real estate cycles, but the overall trend of property values is always up.
• The property you own is always working for you, no matter what you are doing. Your property doesn’t go on vacation with you; it keeps right on working twenty-four hours per day, seven days per week.
• Provide you with some tax shelter for your rental income. You can depreciate the property over time, creating a paper loss to offset other rental income.
Types of Income-Producing Real Estate
* Residential Rental Property
* Single Family Homes/Condos
* Duplex
* Tri-plex
* Four-plex
* Commercial Rental Property
* Larger multi-unit apartments
* Office buildings
* Retail buildings and strip malls
* Warehouses
* Industrial buildings
* Mixed-use properties
Keys to Good Property Management
1. Good property management begins with buying good buildings.
a. Choose good locations.
b. Take pride in your properties.
c. A well-maintained building will attract better tenants and will bring higher rents.
2. Managing Tenants
a. Keep your relationship with your tenants strictly professional.
b. You should be friendly, pleasant, and treat your tenants with respect; however, maintaining a business relationship is essential.
c. Make sure your tenants know the rules and then enforce the rules.
i. Tenant responsibilities vs. landlord responsibilities
ii. Accountability
3. The paperwork for tenants
a. Application with permission to conduct credit and background checks for every responsible applicant.
i. Fee of $20 to $50 to conduct these checks
ii. Red flag if they show any reluctance regarding credit and background checks!
b. Reference from past landlords, not the current landlord, for every applicant
c. Legal photo I.D. of every applicant; make copies for your records
i. Information must match applications and credit reports
d. Evaluate debt-to-income ratio.
i. Rent should be no more than 30 to 35 percent of the total monthly income
e. Rental agreement or fixed-term lease that covers all facilities covered by the agreement (i.e. parking, storage locker and unit description) and that covers every occupant of every property.
i. Firmly establish the number of occupants allowed in the property.
ii. Do not allow unregistered or unsigned tenants to occupy the unit!!! (Except guests, who should be limited to one or two nights per month)
f. Make sure pet restrictions are very firmly established
g. Move-in condition inspection form – signed by all tenants and the landlord or property manager
h. List of any special rules for pools or other amenities
4. Keeping your tenants
a. Getting new tenants costs you money; try to keep the ones you have (if they’re good tenants)
b. Remember tenants’ names, as well as their children’s
c. Remember tenants’ birthdays, and send cards or small gifts
d. Do maintenance promptly. If a request for a repair can’t be handled promptly, call the tenants and tell them when it will be done
e. Set high expectations for your tenants in keeping the property in good condition, and compliment them on doing so.
5. Single Family Homes (SFH) vs. Multi-unit Apartments
a. Single family homes can be very easy to manage.
i. Tenant is responsible for all maintenance and minor repairs, subject to state and local laws and regulations.
ii. Tenants are often former homeowners who are just “between” homes.
b. Multi-unit apartments provide economy of scale for management and maintenance.
i. Consider hiring a management company to manage the property
ii. Condo conversions are possible on some buildings (potential for large profits).
6. Recordkeeping
a. This is a business, not a hobby; keep very good records!
b. A good CPA or accountant can save you money
c. Know what your expenses really are
7. How to hold title
a. For asset-protection purposes, each rental property should be owned by its own separate legal entity.
b. Seek knowledgeable, competent, professional assistance in establishing how title will be held for each property.
Owning income-producing rental properties can be your key to a financially secure future if you buy right and manage right. Additionally, when you are older and tired of managing your properties, you can sell and reap the harvest from your rental tree. I advise you to consider a 1031 exchange into a tenant-in-common structure (apartment complex or commercial property) where you get all the benefits of real estate ownership, but have none of the responsibility. It’s nice to become a “mailbox manager.” Just go to the mailbox each month and get your check. You’ve earned it!!!